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The IRS released a simplified procedure allowing certain small businesses to change a method of accounting under the final tangible property regulations on a prospective basis for the first taxable year beginning on or after Jan. 1, 2014, without completing and filing Form 3115, “Application for Change in Method of Accounting.”
Rev. Proc. 2015-20
was released by the IRS on Feb. 13 and is effective immediately.
A taxpayer is eligible to apply the simplified implementation procedures if it has one or more trades or businesses that have either:
- Total assets of less than $10 million as of the first day of the taxable year for which a change in method of accounting under the final tangible property regulations and corresponding procedures regarding related changes in method of accounting is effective
- Average annual gross receipts of $10 million or less for the prior three taxable years, as determined under Treas. Reg. Sec. 1.263(a)-3(h)(3) (the small taxpayer election for certain repairs and improvement expenditures for eligible buildings)
The revenue procedure applies to a trade or business only if it meets one or both of the previous two criteria.
The final tangible property regulations include both TD 9636
, regarding when costs incurred to acquire, produce or improve tangible property must be capitalized or may be deducted, and TD 9689
, regarding certain depreciation rules and full and partial dispositions of tangible depreciable property. (For more on the final tangible property regulations, see Tax Flash 2013-13 and Tax Flash 2014-10).
The final tangible property regulations generally apply to taxable years beginning on or after Jan. 1, 2014, although certain provisions are applicable to costs incurred on or after taxable years beginning on or after Jan. 1, 2014.
The previous procedures for implementing the final regulations were included in a series of revenue procedures (Rev. Proc. 2014-16, Rev. Proc. 2014-17 and Rev. Proc. 2014-54), which were recently modified by and consolidated into Rev. Proc. 2015-14
. These procedures generally require that changes in methods of accounting to comply with the final tangible property regulations should be implemented using Section 481(a) to avoid duplication or omission (except for provisions applicable to costs incurred on or after taxable years beginning on or after Jan. 1, 2014).
Section 481(a) requires a look-back adjustment computed as if the business had always used the new method of accounting. Additionally, the procedures require businesses that are changing a method of accounting to implement the final tangible property regulations to complete and file Form 3115.
Rev. Proc. 2015-20 effectively allows small businesses that make changes in methods of accounting for the first taxable year that begins on or after Jan. 1, 2014, to elect to make the changes prospectively by using a cut-off basis.
Thus, small businesses that must change methods of accounting to comply with the new regulations can make a Section 481(a) adjustment that takes into account only amounts paid or incurred, and dispositions, in taxable years beginning on or after Jan. 1, 2014 (i.e., there is only a Section 481(a) adjustment computed back to 2014 when a change is made in a future year). The election must be applied to all of the final tangible property regulations, including dispositions. Accordingly, businesses are not allowed to apply certain rules, such as the treatment of repair expenditures, prospectively, and make disposition method changes with a Section 481(a) adjustment. Additionally, businesses making this election do not have audit protection.
Businesses making the election to apply the final regulations prospectively have the option of making certain changes in method of accounting to comply with the regulations on the federal tax return without filing a Form 3115 or a separate statement for the business’s first taxable year ending on or after Jan. 1, 2014.
Special transition rules apply for eligible businesses that already filed the federal tax return for the first taxable year beginning on or after Jan. 1, 2014.
Implications and next steps
This is truly welcome relief for small businesses that do not wish to take advantage of the cash tax savings opportunities in the regulations because of the increased burden and cost of implementation. Allowing small businesses to elect to apply the regulations prospectively and waive the requirement to file a Form 3115 greatly reduces their burden in implementing the regulations.
Businesses taking advantage of the simplified procedures must still apply the new rules to their assets on their 2014 tax returns. This may require changes in the manner in which expenditures for certain assets are recovered, such as current expense, deferred materials and supplies expense, and depreciable assets. Additionally, taxpayers will need to determine whether to make certain elections, such as the de minimis
rule, the small business election for repairs on eligible buildings or the election to follow book capitalization of repairs — all of which require an annual statement to be attached to the tax return.
Similarly, taxpayers that do not track dispositions of certain assets (for example, personal property grouped as one asset in the fixed asset system) should continue to determine whether to make a general asset account election, which requires checking a box on Form 4562, “Depreciation and Amortization.”
Taxpayers considering the less burdensome implementation rules should be aware that the simplification comes at the cost of the missed opportunity to accelerate deductions on certain costs capitalized in prior years. Taxpayers will not be able to file changes in future years to accelerate such basis from years prior to 2014.
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